When I meet someone new and they learn I’m an Investment Advisor, one of the most common follow-up questions is “How is the market?”  While that question matters in the short term, we often overlook a more fundamental idea: understanding what a market is in the first place.  This is important because the structure of a market shapes its outcomes.

Judd Kessler, a professor at the Wharton School of Business, explores this topic in his book, Lucky by Design: The Hidden Economics You Need to Get More of What You Want. At its core, a market is a way to allocate scarce resources.

Kessler offers a helpful way to understand how different markets work, which he calls the "three E’s." The first is efficiency, which means making sure resources are not wasted and are put to their best use. The second is equity, which is about treating market participants fairly. The third is ease, which means making transactions simple and removing unnecessary obstacles.

Every day, I work in financial markets, using tools like stocks to help clients reach their goals. In these markets, prices are the main signal and are set freely by supply and demand. The stock market is a remarkably efficient way to allocate capital. It helps companies access funding and gives investors the chance to own part of more than 44,000 publicly traded companies worldwide, with a combined value of over $125 trillion USD.¹   In terms of equity, anyone can participate in the stock market, provided they have the money needed to purchase shares.  The market also emphasizes ease and stock exchanges can execute transactions in as little as 0.04 seconds, which is about two and a half times faster than the blink of an eye.²

There are also other types of markets where prices do not adjust freely and they often run into challenges.  When prices are set too low, more people want the product than there is supply, which leads to shortages. Rather than prices deciding who gets access, other methods take over, such as first-come first-served systems also known as waiting lists. Anyone who has tried to register a child for a popular summer camp or buy tickets to a Taylor Swift concert knows how challenging these situations can be.  These markets emphasize equity to try and give everyone a fair chance, but they make sacrifices in terms of efficiency and ease, so access often depends more on timing or luck.  The book also explores other market structures that allocate resources without using any price signal, such as lotteries or algorithms.

The structure of markets shapes not only our investments but also many aspects of daily life. Understanding how markets determine who gets what and why can help us all make better decisions.

Stay disciplined,

-Andrew

Sources: 1) OECD 2) Fidelity